Electronic trading of securities has increased with advances in technology. New trading mechanisms have opened up new markets for different securities. One example of a new trading mechanism is the pari-mutuel derivative call auction (“PDCA”) developed by Longitude, Inc.® of Hoboken N.J. Longitude's PDCA enables the creation and trading of new derivatives products. Certain aspects of Longitude's PDCA are provided in their U.S. Pat. No. 6,321,212, the contents of which are incorporated herein in their entirety for all purposes.
In general, Longitude's auction allows traders to participate in new derivatives markets. For example, the assignee of the present application, supports the trading of a new class of derivatives, allowing investors to hedge against surprises in economic statistics by conducting auctions based on U.S. Non-Farm Payrolls and other economic derivatives. As other examples, traders are able to trade in auctions based on U.S. GDP numbers, jobless claims, etc. That is, traders are provided with a direct means for trading the forces that drive the economy, providing new and significant hedging tools.
Each auction may involve a number of participants, including one or more investors, traders, brokers, auction administrators, and market makers. In general, the brokers and traders submit orders to the auction through the auction administrator and the market maker provides liquidity to each order submitted to the auction. In some auctions, the auction administrator and the market maker may be the same entity. In a typical PDCA auction run by Longitude, investors submit their orders to a broker who submits orders to the auction. In a pari-mutuel auction, individual orders to buy are not matched against specific orders to sell; instead, orders define a single set of pari-mutuel prices against which the orders clear. Order pricing and fills are determined using pari-mutuel principles, and each order creates liquidity for other orders.
Currently, market makers provide general liquidity in traditional continuous trading markets by submitting orders for each instrument (for example, a order is submitted for each option at each strike). This requires the creation, submission, and management of a very large number of orders and may limit the number of instruments available to participants in an auction market. As a simple example, in an auction with 20 strikes, over 1427 options are required to cover the auction (including, one forward contract, 19 vanilla calls, 19 vanilla puts, 20 digital calls, 20 digital puts, 18 vanilla straddles, 190 digital ranges, 190 digital strangles, 190 digital risk-reversals, 190 vanilla call spreads, 190 vanilla put spreads, 171 vanilla straddles, 171 vanilla risk-reversals, 19 vanilla knockout calls, and 19 vanilla knockout puts). In general, in an auction with N strikes, there are (3.5*N2+1.5*N−3) options to choose from, rendering the objective of providing liquidity to both buy and sell orders of all these options a complicated one. To provide liquidity to both buy and sell orders in an auction having 20 strikes, there are over 2,800 option orders to enter and maintain during the auction. That is, providing “general liquidity” (or, liquidity to all instruments in the auction) in such a manner is operationally inefficient.
Further, such an approach is inefficient from a financial risk perspective. The entry of such a large number of orders to achieve general liquidity can expose the market maker to financial risk—the risk associated with the large number of orders may be higher than desired. It would be desirable to provide improved systems and methods that allow a market maker to efficiently achieve general liquidity (or liquidity to all instruments in the auction) for a given level of potential risk allocation.